This post is the seventh in a series that looks at the relationship between real economic growth and the top individual marginal tax rate. The first looked at the period from 1901 to 1928, the second from 1929 to 1940, the third from 1940 to 1950, the fourthh looked at 1950 – 1968, and the fifth from 1968 to 1988. Because the Reagan era is so pivotal in the American psyche, it was also covered again in the sixth post, which looked at the period from 1981 to 1993. This post will look at the period from 1988 to the present.

Before I begin, a quick recap… both the 1901 – 1928 period and the 1929 – 1940 failed to show the textbook relationship between taxes and growth. In fact, it seems that for both those periods, there was at least a bit of support for the notion that growth was faster in periods of rising tax rates than in periods when tax rates were coming down. It is worth noting that growth from 1933 to 1940 was generally quite a bit faster than at any other peacetime period since data has been available, both on average and for individual years. Not remotely what people believe, but that’s what it is.

In the 1940 – 1950 period, we did observe slower economic growth following a tax hike and faster economic growth followed a tax reduction. However, that happened when the top marginal tax rate was boosted above 90%.

Interestingly enough, though the so-called “Kennedy Tax Cuts” are often used as one of the prime exhibits on the benefits of cutting taxes, a look at the 1950 – 1968 period yields no such conclusion. Growth rates were already rising before the tax cuts occurred in 1964 and 1965, reached a peak when the tax cuts took place, and started shrinking immediately afterwards. The other period that is always pointed to as evidence that tax cuts spur growth is the Reagan years, which showed up in the 1968 – 1988 and the 1981-1993 posts. It turns out that put into context, the Reagan years produced one year of rapid but not particularly extraordinary growth a few years after tax cuts began. That’s it. In fact, its worse than that… during the Reagan Bush 1 years, aside from that one good year, growth tended to shrink as tax rates were slashed.

Real GDP figures used in this post come from Bureau of Economic Analysis. Top individual marginal tax rate figures used in this post come from the IRS. As in previous posts, I’m using growth rate from one year to the next (e.g., the 1980 figure shows growth from 1980 to 1981) to avoid “what leads what” questions. If there is a causal relationship between the tax rate and the growth rate, the growth rate from 1980 to 1981 cannot be causing the 1980 tax rate. Let me stress this point again as I’ve been getting people e-mailing me to tell me I’ve got the growth rates shifted a year. That is correct, and is being done on purpose (and is shown on the graph labels). To avoid questions of causality, the growth rate in year X used in this post is the growth rate from year X to year X+1. And when I say “to avoid questions of causality” – you’d be amazed at how many people write me when I don’t do this and insist that sure, higher tax rates seem to be correlated with faster growth, but that’s because when growth is faster governments feel more willing to charge higher tax rates.

So here’s what the period from 1988 to the present looks like [update: Graphic Title Corrected; h/t Eric Whitaker)

Once again, the data fails to show anything resembling the old “lower taxes = faster growth” story. In fact, once again, it kind of looks like things go the other way. The two biggest dips in the graph occur when tax rates are at low points (28% and 35%). The highest tax rates also coincide with the fastest overall growth. But no doubt next week’s post looking at the next period will be the one that finally shows what everyone believes is there. Oh wait, we’ve run out of years.

Now, I’m sure someone will bring up the fact that there was a tech boom and the internet in the late 1990s. And no doubt there was some of that. But that doesn’t explain why only once did the graphs appear to show that cutting tax rates correlates with faster economic growth, and that one time occurred in the middle of WW2 during what was essentially a command economy when tax rates were above 90%. Talk about a special case. Conversely, most of the other graphs that we’ve seen in this series have not shown any relationship between tax rates and economic growth. And then there were a few, such as those showing the Reagan era, that seem to at least suggest that faster growth was more likely when tax rates were higher. None of this matches what we hear in the liberal (ha ha) media. None of this matches what I see in econ textbooks. It doesn’t match what I read in economics journals. But anyone, and I mean anyone, can do these graphs. Not sure many people can replicate Barro.

Next post in the series… what it all means.

As always, if you want my spreadsheets, drop me a line. I’m at my first name which is mike and a period and my last name which is kimel (note that I’m not from the wealthy branch of the family that can afford two “m”s – make sure you only put one “m” in there) at gmail period com.

Comments (9)

From 1790 to 1910, an era of small government, no or little income taxes and no Federal Reserve trend US per capita GDP growth was 1.4%.

Since 1920 an era of ever growing government, large and growing government, with big personal and business taxes and a strong central bank real per capita GDP growth was 2.1%.

Yon can vary theres numbers any way you want — I like to use the 1859 t0 1925 era when modern financial capitalism had come into being but before the great depression and for this era trend real per capita GDP growth rose to 1.6%. After 1950 trend growth, an era of large government and high taxes,trend real per capita growth was 2.1%.

US economic history shows that the claim of big government harming growth is strongly contradicted by the data. The US has consistently experienced higher growth in the era of big government than it did under small government.

Mike Kimel

September 19, 2011 9:48 am

Spencer,

The problem is, this mistaken belief is harming us. The clowns on tv who debate this stuff and tell us X or Y or Z don’t seem to realize that peddling this mistaken belief has negative consequences. Not to them, of course. But slower growth is not a number. Its lost income, lost jobs, lifesaving procedures foregone, foreclosed homes and shattered dreams.

Collectively, we’ve brought this on ourselves. And collectively, we deserve it for buying into the BS.

rl love

September 19, 2011 10:33 am

I don’t know how the Chinese government compares in terms of size, but… they are proactive while we are reactive in most cases. They have of course averaged 6.5% growth over the past 25 years or so.

I’ve heard it argued that their unprecedented growth is due to a low starting point, so, I feel compelled to mention that the Great Depression provided a low starting point for the US economy as well. But the Chinese have needed a World War to rise from their ashes.

It may follow then that growth is not so much about the size of the government, as it is about good management. There are now of course a few nations showing that growth in the US has always been less than impressive considering the vast resource base that the US has. Brazil for example has nothing close to our agricultural advantages yet they too are showing growth rates beyond any in US history. But Brazil has Guido Mantega and the US has Timmy.

It would be very interesting to know how the US would have done over these past decades without the advantages of ‘world currency status’. There would of course be endless counterfactual considerations, but… without dollar recycling and the freedom to make adjustments such as those of the Plaza Accords, I suspect that we would conclude that the US economy has always been poorly managed and that the periods when the US government increased the channelling of productivity gains to where those gains could do the most good… those were the least poorly managed times.

Scott F

September 19, 2011 2:25 pm

Has the US ever had the kind of export markets that the BRIC countries enjoy – namely, the US itself?

Mike Kimel

September 19, 2011 4:45 pm

One has to be careful with Brazil. They have historically been poorly managed. A few good years can go a long way toward making up for utter disastrous management for a long time.

As to periods where the US might have been well-run… click on the 1929-1940 link. You might be surprised.

Darren

September 19, 2011 6:02 pm

Spencer,

What role did the invention of electricity and the automobile play in that? You put a false choice that growth was directly responsible because of big government with no supporting evidence. How do you know that Big Government didn’t hinder even more growth and wealth creation that what we have seen?

Mike Kimel

September 19, 2011 6:52 pm

Darren,

You seem to be missing something. See, as I noted in the post, the tech boom happened during the 90s and that no doubt made the higher taxes of the 90s (relative to the period preceding the 90s and the period following the 90s) look better. But the fact of the matter is, there always seems to be something. Lower taxes would produce faster economic growth except for X, or Y, or Z.

I’ve stated it before, I’ll state it again – a theory for which just about every observation is a special case is a lousy theory.

Besides, it seems you suffer from the Tyler Cowen The Great Stagnation syndrome: “yes, growth rates were slower during the periods in which the policies I favor were in place, but no, that cannot possibly be due to the policies I favor.”

Darren

September 19, 2011 8:29 pm

Mike,

The day you can convince me that the policies you favor actually do what you claim they do….is the day I change my position.

rl love

September 21, 2011 11:33 am

No, but… nor has China or Brazil enjoyed the benefits which the US has in regards to gains from international lending and platforming.